It is quite logical to spend some time on understanding the complexities behind annuities before putting your money into an annuity. Annuities are often not simple financial instruments that multiply your money. There are many factors and calculations hidden behind your money’s growth. It is important to know the advantages and disadvantages associated with each such calculation. Let us briefly discuss about the key concepts behind how an annuity works.

An annuity is a contract between the buyer and a company, generally an insurance company. In this contract, the insurance company undertakes to return your money after a period of time with interests. The company uses your money to do further invest in various industrial sectors and reap profits. It basically pays you back your interest from this profit.

There are many types of annuities depending on how you want your money back and how much interest are you seeking. Broadly speaking there are three main clusters of annuities – fixed annuities, variable annuities, and equity-indexed annuities.

With a fixed annuity, the insurance company puts in the premiums in investments that are fixed-rated, such as bonds. Hence you earn a guaranteed and fixed rate of return for a period. When the period ends, and if your money still continues to remain with the company, your investment is put into a new time period at a new rate, with your notice. The new rate may be more or less, depending on the state of the insurance company’s financial health.

Variable annuities are different in calculations and approach. When you choose a variable annuity, your money is invested in the likes of stocks, bonds, mutual funds, and other industrial sectors. The investor knows the sector where his money, along with many others, is invested and has the power to shift the sectors. The return on the money decides the interest rate at which your money will grow. It can be high performing or a failure. With a ‘deferred variable annuity’, where investment sectors can shift, the money developed during the accumulation period can vary substantially. The rates of interest are much higher than fixed annuities, but the stakes involved are high too! In other words, it can lead to a situation of no growth.

In general the funds for a ‘fixed annuity’ are held by the insurance company in a general account, whereas the funds for a ‘variable annuity’ are held in a separate account. A third type of annuity contract allow a mixture of mixed and variable where certain parts of your investment are put to risk (you share the risk) and certain parts are kept aside secured. These types are called equity-indexed annuities.

It is crucial to know about how your money will grow over time and what are the risks involved before you finally sign the contract. For this, use annuity tables, calculators and expert opinions about different options that you hold.

For more information and assistance with respect to how annuities work, consult our financial planners at AnnuityLibrary.com. To submit your questions, Click here or calltoll-free at 1-800-998-4056.